Why I'm Staying Away From A123

Battery maker A123 Systems (NAS: AONE) seems to be going through a rough patch at present. After posting disappointing fourth-quarter numbers and an embarrassing balance sheet, the company is now replacing the faulty batteries it sold to five customers. The reasons being cited include the possibility of "premature failure" of these battery packs and a subsequent fall in performance.

After A123 released its fourth-quarter numbers, I had expressed concerns that Fisker's order cuts would pull the company down. But now it seems A123 has no one but itself to blame for the loss. Recently, a Fisker Karma car shut down during a test simply because of A123's defective batteries -- a big blow to Fisker's reputation, but a bigger one to A123. Fisker is extending warranties and offering free battery replacements in a bid to salvage its dented status.

Cause and effectA manufacturing defect in A123's Michigan plant apparently led to the production of faulty lithium ion battery modules and packs, which effectively translates to poor battery performance. The problem comes with a $55 million price tag -- at least 18% of the company's expected revenue for this year and more than 30% of its current market capitalization. A123 plans to fund this heavy expenditure spread over several quarters.

But that's just one part of the problem. Every battery pack made by A123 contains more than 300 cells, and even a single defective cell can damage the entire pack. Needless to say, this makes the company's replacement process very tedious and expensive. At the same time, Fisker Automotive is one client A123 simply cannot afford to ignore, given the fact that the batteries sold to Fisker alone accounted for around 25% of A123's total revenue generated in 2011.

This is not the first time that A123 has been the cause of Fisker Automotive's embarrassment. Earlier this year, Fisker recalled some Karma units after defective hoses were found on the car's A123-manufactured battery packs, which could have led to coolant leaks.

As I had mentioned earlier, A123 has planned to increase its client base in a bid to reduce its dependence on Fisker. For instance, General Motors (NYS: GM) plans to install A123 battery packs on its Chevy Spark EV slated for 2013. However, with the recent battery fiasco, I don't see new clients flocking to the company anytime soon.

It's not just the batteries...What does not help is the fact that A123's bottom line has remained in the red since 2009, the year it went public. In fact, some analysts believe the company may have to raise funds as early as the third quarter of this year to meet working capital requirements. Furthermore, the company's huge $54 million inventory may include batteries that possess defective cells.

The Foolish bottom lineA123's numbers don't look good, nor does its performance. The company's credibility has taken a tumble, which explains why its shares are trading at an all-time low. A123 sure has a lot of cleaning up to do. Till then, I would watch this stock from a distance.

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